IP transactions can raise complex tax issues on which specialist advice should be sought. But the transactional IP lawyer needs to have at least a basic understanding of tax issues, so that he or she can recognise tax issues, instruct specialists where necessary, and (particularly where the transaction does not justify the close involvement of a tax specialist in negotiations) draft and negotiate wording to deal with tax issues in IP agreements.
IP Draughts was recently involved in seeking tax advice in relation to the structuring of agreements with a Gibraltar company. The client, a privately-owned technology company, was being prudent to ensure that no significant tax risks or tax-saving opportunities arose from the transaction. The clients and IP Draughts were pleasantly surprised at how down-to-earth and user-friendly tax counsel was. The advice given was practical and authoritative. Behind the scenes, IP Draughts and his colleagues had worked hard to find the right tax barrister who was sufficiently experienced, understood both UK and Gibraltar tax, was used to helping individuals and SMEs, did not cost a fortune, and had time available to help us. It came down to two or three names at the London Bar.
The main tax issues that usually arise in IP licence agreements are the following:
- Withholding tax. Must the licensee deduct income/corporation tax from the amount of payments due under the agreement, and pay only the net amount to the licensor, paying the remainder to the tax authorities in the licensee’s jurisdiction? Most countries have rules on the withholding of tax at source on royalties and other IP payments. This tax is commonly known as withholding tax. The tax is being levied on the licensor, and the licensee is acting as a tax collection agent. It may be possible to get permission from the tax authority to pay the royalties without deduction of tax, if a double-taxation treaty is in existence between the country of the licensee and the country of the licensor. Typically, the licensor produces evidence from its tax authority that it is a tax payer in the licensor’s country, and this evidence is provided by the licensee to the tax authority in its country.
- Drafting for withholding tax. Licence agreements typically say one of two things: (a) the licensee can deduct withholding tax but must cooperate with the licensor to seek an exemption from the licensee’s tax authority, or (b) the licensee must “gross up” the royalty payment so that the amount is as stated in the agreement. In the latter case, the licensee may also have to make a withholding tax payment, so the licensee is taking the risk of tax being levied on the licensor.
Value Added Tax. In principle, payments under IP licence agreements are subject to VAT, as payments for “intellectual services”. The VAT regime applies across the EU. VAT law is complex, but in summary: (a) invoices from a UK licensor to a UK licensee are likely to include a demand for VAT on the payment, (b) invoices from a UK licensor to a licensee in another EU country are likely not to include VAT – VAT is accounted for by the licensee to its local VAT authority under a complex “reverse charge” procedure but VAT is not paid to the licensor, and (c) invoices from a UK licensor to a non-EU licensee are likely not to be subject to VAT at all, as they are outside the scope of VAT. However, special rules may apply, eg payments arising from litigation may be treated differently.
- Drafting for VAT. Unless otherwise stated in the agreement, any payments stated in the agreement are exclusive of VAT. If the licensee is obliged to pay VAT to the licensor, it will do so by paying an additional amount, on top of the stated amount, if presented with a valid VAT invoice. Typically business-to-business agreements within the EU state that payments are exclusive of VAT. Typically, neither party ends up with a VAT liability as at the end of each VAT accounting period it will simply subtract the VAT paid to suppliers from the VAT charged to customers and pay the net amount to the VAT authorities. Usually, it is only the end consumer who pays VAT but cannot recover it in his tax accounts. US parties to licensing transactions sometimes object to clauses that state that payments are exclusive of VAT, as they equate VAT with sales tax. In fact the regimes are very different.
These are not the only tax issues that can arise, but they are the most common. In some countries, stamp duty may need to be considered. The UK abolished stamp duty on future transactions over a decade ago. In some cases, other taxes may need to be addressed in contracts, eg whether a party has sufficient rights to qualify for the “patent box” or for R&D tax credits. However, these are specialist areas and have not yet generated any standard contract clauses – unless you know differently?
IP Draughts invites readers to share any standard tax-related wording that they have seen or used in IP agreements.